Your service-connected disability income may be partially or totally excluded from taxation, depending on its nature.
Please see this extract of IRS Publication 525 to see if you qualify.
Military and Government Disability Pensions
Certain military and government disability pensions are not taxable.
Service-connected disability.
You may be able to exclude from
income amounts you receive as a pension, annuity, or similar allowance
for personal
injury or sickness resulting from active
service in one of the following government services.
-
The armed forces of any country.
-
The National Oceanic and Atmospheric Administration.
-
The Public Health Service.
-
The Foreign Service.
Conditions for exclusion.
Do not include the disability
payments in your income if any of the following conditions apply.
-
You were entitled to receive a disability payment before September 25, 1975.
-
You were a member of a listed government service or its reserve component, or were under a binding written commitment to become
a member, on September 24, 1975.
-
You receive the disability payments for a combat-related injury. This is a personal injury or sickness that:
-
Results directly from armed conflict,
-
Takes place while you are engaged in extra-hazardous service,
-
Takes place under conditions simulating war, including training exercises such as maneuvers, or
-
Is caused by an instrumentality of war.
-
You would be entitled to receive
disability compensation from the Department of Veterans Affairs (VA) if
you filed an application
for it. Your exclusion under this
condition is equal to the amount you would be entitled to receive from
the VA.
Pension based on years of service.
If you receive a disability pension
based on years of service, in most cases you must include it in your
income. However,
if the pension qualifies for the exclusion
for a service-connected disability (discussed earlier), do not include
in income
the part of your pension that you would have
received if the pension had been based on a percentage of disability.
You must
include the rest of your pension in your
income.
Retroactive VA determination.
If you retire from the armed services
based on years of service and are later given a retroactive
service-connected
disability rating by the VA, your retirement
pay for the retroactive period is excluded from income up to the amount
of VA
disability benefits you would have been
entitled to receive. You can claim a refund of any tax paid on the
excludable amount
(subject to the statute of limitations) by
filing an amended return on Form 1040X for each previous year during the
retroactive
period. You must include with each Form 1040X
a copy of the official VA Determination letter granting the retroactive
benefit.
The letter must show the amount withheld and
the effective date of the benefit.
If you receive a lump-sum disability
severance payment and are later awarded VA disability benefits, exclude
100%
of the severance benefit from your income.
However, you must include in your income any lump-sum readjustment or
other nondisability
severance payment you received on release
from active duty, even if you are later given a retroactive disability
rating by
the VA.
Special statute of limitations.
In most cases, under the statute of
limitations a claim for credit or refund must be filed within 3 years
from the
time a return was filed. However, if you
receive a retroactive service-connected disability rating determination,
the statute
of limitations is extended by a 1-year period
beginning on the date of the determination. This 1-year extended period
applies
to claims for credit or refund filed after
June 17, 2008, and does not apply to any tax year that began more than 5
years
before the date of the determination.
Example.
You retired in 2009 and receive a
pension based on your years of service. On August 3, 2015, you receive a
determination of
service-connected disability
retroactive to 2009. Generally, you could claim a refund for the taxes
paid on your pension for
2012, 2013, and 2014. However, under
the special limitation period, you can also file a claim for 2011 as
long as you file
the claim by August 3, 2016. You cannot
file a claim for 2009 and 2010 because those tax years began more than 5
years before
the determination.
Terrorist attack or military action.
Do not include in your income
disability payments you receive for injuries resulting directly from a
terrorist or
military action. However, you must include in
your income any amounts that you received that you would have received
in retirement
had you not become disabled as a result of a
terrorist or military action. Disability payments you receive for
injuries not
incurred as a direct result of a terrorist or
military action or for illnesses or diseases not resulting from an
injury incurred
as a direct result of a terrorist or military
action may be excludable from income for other reasons. See Pub. 907,
Tax Highlights
for Persons with Disabilities.
A terrorist action is one that is
directed against the United States or any of its allies (including a
multinational
force in which the United States is
participating). A military action is one that involves the armed forces
of the United
States and is a result of actual or
threatened violence or aggression against the United States or any of
its allies, but
does not include training exercises.
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